Economist, Telegraph Columnist, Broadcaster

China may prevent global recession, but it won’t pick up eurozone’s bills

A serious global slowdown looks likely in 2012 – or, at least, that’s the way conventional wisdom is shifting. The eurozone, of course, remains the epicentre of world-wide angst, its debt crisis threatening to cause havoc across an economy about the same size as that of America. Eurozone sovereign yields eased slightly last week, but massive questions remain.

Will the “Merkozy” plan work? Will Germany print money? Will monetary union be slimmed-down in a relatively ordered manner, with some smaller countries leaving? Or will the entire structure collapse, the Pan-European edifice crashing down amidst chaos and recrimination? No-one knows. But the stakes are now so high, and the doubts so acute, that just the threat of a “euroquake” has brought the global economy, in the eyes of some, to the brink of recession.

Just three years ago, at the end of 2008, our economic predicament looked dire. Yet here we are once more. The difference is that, back then, while Western governments were heavily indebted, they still had fiscal ammunition in their locker. That is not the case today.

Having squandered countless billions bailing-out rather than shutting-down insolvent financial institutions, the West is on the edge of a fiscal precipice. The resulting “zombified” banks, by refusing to lend, are stultifying economic activity, weakening government balance sheets even more. The economically-illiterate claim that the likes of the UK and the eurozone are barely growing because “austerity isn’t working” and government spending is being cut “too far and too fast”. What tosh!

The reality is that state expenditure is still rising and borrowing remains extremely high, with West European national debts still spiraling to the point where some of the world’s most advanced economies can barely roll-over their loans. Yes – yields eased in recent days, but largely as a result of covertly printed money, central bank bond-buying and governments forcing nationalized banks to buy sovereign paper. This situation isn’t sustainable. So it will not be sustained.

The reason we aren’t growing has nothing to do with “austerity”. Tough measures to rein-in fiscal deficits have barely begun. The principal cause of the West’s economic torpor is that our banks remain utterly moribund, weighed down by cash-hoarding and undisclosed off-balance sheet losses, the inter-bank market paralyzed by fears of counter-party risk. Fixing that, breaking the deadlock, involves shaking-down the banks, taking their mendacious executives down a peg or three and, while standing behind ordinary depositors, forcing a wholesale restructuring.

The banks, though, are still too powerful. Our political leaders, in a show of cowardice that future historians will deride, remain incapable of standing-up to the money-men. And so we carry on, sleep-walking towards disaster, as Western Europe heads towards a toxic combination of high inflation, economic stagnation and explicit sovereign defaults.

Having said all that, I still don’t buy the idea of a global recession in 2012. In my view, the world economy will continue to expand next year, albeit by 3pc or so, down from the 4pc that looks likely in 2011. One reason is that in the US, for all the regulatory lapses and policy faults, the banks are being slowly restructured and the wheels of finance are once again starting to turn. The American economy could grow by 2pc in 2012, roughly the same as this year.

The main reason I don’t foresee a global recession, though, is that I remain relatively optimistic about prospects for the large emerging markets – not least China. The Peoples’ Republic, to say the least, is no economic side-show. The second-largest economy on earth, China expanded by around 9.2pc this year, accounting for around two-fifths of global growth. Yet concerns are mounting that the world’s most populous country is heading for a hard landing. And that, of course, would have grave implications for economies elsewhere.

It’s certainly clear that growth is rapidly replacing inflation as Beijing’s main policy concern. The Chinese leadership last week agreed, at its most important economic summit of the year, that the major macro risk for their country, amidst a worsening global outlook, has now shifted from rising prices to an economic slump.

A slew of recent Chinese data shows growth easing, driven by fewer housing sales, lower construction spending and slowing exports, not least to Europe. The most alarming data, perhaps, comes from the all-important residential property market. The vast majority of Chinese savers, hemmed in by a closed capital account, have few investment options. They have to choose between a state bank (which gives them a negative real interest rate), the domestic stock market or property. Many go for property, with house prices an even bigger topic of conversation among China’s growing middle class than among their counterparts in the UK’s leafy home counties.

Back in 2009, in the aftermath of the Lehman collapse, Beijing’s central economic planners launched an almighty stimulus package, driven by a huge increase in bank lending. This did the trick, and kept the economy expanding, but at the cost of an over-heated housing market and high inflation.

In response, state banks have since been ordered to curtail loan growth, which has hit the property market hard. The price of new residential units fell month-on-month in October in no less than 34 of the 70 mainland cities tracked by China’s National Bureau of Statistics. Property market weakness has now spread from Beijing and Shanghai to the smaller cities.

The reality is, though, that the Chinese government can reverse this trend pretty much as and when it chooses. The important goal, up until now, has been to squeeze inflation, which has recently been achieved. During the year to November, China’s CPI growth was 4.2pc, down for the fourth straight month. That done, the likelihood now is that Beijing’s policymakers will yank on the policy-lever marked “expansion”. Already, reserve asset ratios on Chinese banks have been cut by 50 basis points. It won’t be long, in my view, before we see a sizeable rise in the vital loan-quota to which the banking sector must adhere.

Many assume that China will ultimately choose to bail-out the eurozone as a result of self-interest – not least because the European Union is the country’s biggest trading partner. While this view might be reassuring for some, I don’t believe it is true. For one thing, even if the eurozone stagnates badly, the demand for cheap Chinese goods won’t dry up. In relative terms, as European household budgets are squeezed, it could even increase.

Intra-Asian trade is also rapidly expanding. Commercial flows between China, Taiwan, South Korea and Japan now account for more than half of their total trade. The Chinese economy also depends heavily, for the foreseeable future at least, not on European demand, but on infrastructure spending funded by the country’s vast $3,200bn haul of foreign currency reserves. It was this kind of spending power which kept China growing by 8.7pc in 2009 – despite widespread predictions the People’s Republic would be dragged down by the West. A hard landing in China? I don’t think so. Now inflation looks licked, Beijing will soon unleash higher loan growth, while channeling yet more billions into more construction and other capital investments, not least by state-owned enterprises.

China has this policy flexibility because it has the money, so can finance a meaningful “Keynesian boost” from cash. European governments, on the other hand, are not only broke, but face massive future liabilities. Assuming China will pick up the bill would amount to yet another policy mistake.